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Not Necessarily Free and Clear III: Imposing Debtor’s Unemployment Insurance Ratings Onto Purchaser?

On April 30, 2009, Chrysler and 25 of its direct and indirect subsidiaries (collectively, “Old Chrysler”) commenced bankruptcy cases that became jointly administered.[i] Scarcely a month later, Old Chrysler sold its assets through a sale under section 363 of the Bankruptcy Code to a newly-formed entity that went on to do business as Chrysler (“New Chrysler”). As discussed in a previous article, a section 363 sale allows a purchaser to take the assets free and clear of “interests” if the court determines that one of the conditions of section 363(f) is satisfied. Though the sale order by which New Chrysler purchased Old Chrysler’s assets did confirm that section 363(f) was satisfied, New Chrysler could not shake off Old Chrysler’s “unemployment experience rating” in certain states. As a result, from June 2009 through June 2013, New Chrysler was charged and paid $50 million more in unemployment taxes than it would have been charged if it had been treated as a new entity.

Chrysler filed a motion against the states in bankruptcy court seeking a confirmation that the order approving the section 363 sale bars these states from applying Old Chrysler’s unemployment experience rating to New Chrysler.[ii] The states, on the other hand, argued that they were within their rights to charge the rates that their ordinary processes deemed applicable.

The process for establishing a company’s unemployment tax usually involves the state forecasting how much money it will need to make benefit payments to that company’s employees. The company’s unemployment experience rating is used as a means of calculating future risks based on prior experience, i.e. past unemployment benefits paid out to former employees.

As a new entity, New Chrysler expected to have a lower unemployment tax burden than Old Chrysler, which had been struggling. New Chrysler’s expectations were frustrated. Michigan, Illinois, and Indiana each applied Old Chrysler’s unemployment experience rating in determining how much to assess New Chrysler for unemployment tax. As a result, New Chrysler was charged 7.5% higher rates in Michigan, 3.7% higher rates in Illinois, and 2.9 % higher rates in Indiana.[iii]

In addressing the contentions of New Chrysler and the states, the Bankruptcy Court for the Southern District of NY focused on whether Old Chrysler’s unemployment experience rate counted as an “interest” within the meaning of section 363(f).[iv] This would become the pivotal point of the debate since a Section 363 sale allows a buyer like New Chrysler to obtain bankruptcy estate assets “free and clear” of interests—i.e., the assets come with a clean slate, or tabula rasa, if you will. If the unemployment experience rating is an ‘interest,” then it must not be allowed to carry forward to the 363 sale purchaser; otherwise, the slate is not truly clean.

Section 363 of the bankruptcy code, however, does not specifically define what an “interest” is. Historically, courts have considered an interest to be an ownership interest in the asset itself – such as a lien.[v] Gradually, as section 363 sales have become a more common means of selling distressed assets, courts have expanded the meaning of “interest.”[vi] However, there have been various contradictory opinions handed down regarding whether the unemployment experience rating of a debtor can be applied to the purchaser of the debtor’s assets.[vii]

In the case of Chrysler, the court ruled that there were broad grounds for construing what constitutes an “interest” in estate property, and this was upheld on appeal by the Second Circuit Court, which determined that “[b]ecause appellants’ [the states’] claims arose from Old Chrysler’s property, §363(f) permitted the bankruptcy court to authorize the Sale free and clear of appellants’ interest in the property.”[viii] The decision in Chrysler’s case reinforces the power and importance of Section 363 when it comes to the value and obligations of companies, and various governments’ roles in the oversight of those businesses. Considering the differing opinions from various court districts about how to interpret that critical word “interests,” it certainly makes this aspect of bankruptcy sale law an even more important and interesting one to follow.

i. In re Chrysler LLC, Case no. 09-500002 (Bankr. S.D.N.Y.), later re-captioned In re Carco LLC, Case no. 09-500002 (Bankr. S.D.N.Y.).] ii. In re Old Carco, 505 B.R. 151 (Bankr. S.D.N.Y. 2014).
iii. Ibid, at page 7
iv. Ibid
v. In re Trans World Airlines, Inc., (“TWA”), 322 F.3d 283, 289 (3rd Cir. 2003)
vi. Ibid
vii. In re PBBPC, Inc., 467 B.R. 1, 10 (Bankr. D. Mass. 2012); In re Wolverine Radio, 930 F.2d 1132, 1147 (6th Cir. 1991).
viii. In re Chrysler, 576 F.3d at 12

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